Gwyn Morgan, the retired founding CEO of EnCana, has a great article in the Globe and Mail today about the shifting balance of power in the global economy posed by both petro dollars and trade flows.  The rise of sovereign wealth funds is provoking calls for greater transparency.

Will the widening cracks in the West create a new global economic order?

November 12, 2007

CALGARY — History demonstrates that events that changed the course of human endeavours could have been forecast by a clear-minded analysis of the big picture.

Unfortunately, it’s hard to focus on the big picture when we’re distracted by disconnected snapshots.

Financial markets, for example, have been battered by the realization that investors couldn’t trust the ratings assigned to structured debt securities. Looking back, the warning signs were clear: instant credit approvals on everything from second mortgages to cars to vacations; oversubscribed low-yield debt issues funding highly leveraged takeovers; financial engineering so extreme that investors couldn’t discern who they were lending to or for what; and staggering Wall Street bonuses driving even more-extreme schemes.

But a much bigger financial earthquake is reversing the centuries-old dominance of Western-based global economic power. It’s an earthquake set off by a combination of petrodollars and trade flows.

More and more of the West’s oil supplies are coming from the Middle East and Russia. As oil gushes out of these countries, enormous amounts of petrodollars flow back to their national treasuries. The rise of oil prices to the $100-a-barrel range further accelerates this enormous West to East wealth transfer.

When it comes to trade flows, the biggest story is China. The world’s workshop has accumulated a foreign exchange surplus of more than $1.4-trillion (U.S.) and it’s growing by about a billion dollars a day. A lot of that money is invested in U. S. and European treasury bills, but an increasing portion is being invested by Chinese sovereign wealth funds into Western real estate, stock markets and private equity. Rising trade in services has also seen India’s economic clout rapidly increase, with substantial Western assets now controlled from Mumbai and Bangalore.

How does all this add up to a global financial earthquake? Well, if you were born in the West after the fall of the Soviet Union, your birthright made you a citizen of one of the countries amongst the top of the world’s wealth hierarchy. Important head offices were almost always located in the West and almost all foreign investment flowed from West to East. Western countries dominated world affairs in every sense.

Now for the earthquake. To put it in the simplest of terms, the West is exporting its cash to buy oil and manufactured goods, and the East is sending the money back to gain ownership or control of Western assets.

Of course, the dominant force in this earthquake is the United States. The world’s biggest economy sends far more cash out to pay for imports than the cash coming back in from exports, resulting in an enormous trade deficit. How can the U.S. sustain such a staggering cash-out versus cash-in shortfall? Economists will give you a long and arcane explanation, but the real answer is quite simple. Many of the dollars sent to pay for Middle Eastern oil and Chinese manufactured electronics return through purchases of Treasury bills and all kinds of assets - including the shares of U.S.-based companies and the very real estate that the country is built upon.

The Sheiks, Oligarchs and Indian entrepreneurs are certainly changing the game in global markets, but it’s the unprecedented power of government-controlled wealth that is really sounding alarm bells in the U.S. and other Western countries. From Abu Dhabi to Qatar to China, governments are awash in cash. Investment Bankers estimate that the multitrillion-dollar sovereign wealth fund sector is growing by half a trillion dollars a year, while a lot of western countries sink deeper into debt. Few sovereign fund owners are democracies and some can’t be considered friends of the West. This has fuelled concern that investment decisions are motivated more by geopolitical power versus normal market considerations. The continuing meltdown of the greenback means the sovereigns get even more for their money, thereby accelerating the process.

Bank of Canada Governor David Dodge recently spoke about the “insufficient transparency” of the sovereigns. U.S. officials have called for international reporting standards. Clay Lowery of the U.S Treasury points out that if the world’s Sovereign funds bought all U.S. and European Treasury bond issues they would still have about a billion dollars left in the kitty. The U.S. has already blocked Chinese and Middle Eastern takeovers in what it defines as strategic industries. Industry Minister Jim Prentice recently served notice that the Harper government would be reviewing rules for corporate takeovers by government-controlled entities. Meanwhile, the EU’s top economic official has stated that sovereign fund investments “will be restricted unless they are more transparent.” One British minister stated: “We don’t want our strategic industries to be owned by a subsidiary of the People’s Republic of China.”

The German government is drafting legislation that would define sectors deemed to be important to national security, while France is calling for action on a wider international level, such as a G7 Code of Practice.

How will these measures change the long-term picture? Not much, I’d say. As long as the West keeps sending cash to satisfy our energy and consumer goods extravagance, ownership and control of everything from Western companies to real estate will keep shifting east.

This earthquake is shaking the very poles around which global power rotates.